Capital Allowances: water facility - intention or objective result?

Are the taxpayer's subjective intentions or motives critical or determinative in establishing whether their expenditure on sealing a road is reasonably incidental to conserving or conveying water for the purposes of paragraph 40-520(1)(b) of the Income Tax Assessment Act 1997 (ITAA 1997)?

No. The taxpayer's subjective intentions or motives are not critical or determinative in establishing whether their expenditure on sealing a road is reasonably incidental to conserving or conveying water for the purposes of paragraph 40-520(1)(b) of the ITAA 1997. The critical or determinative consideration is an objective examination of the results of the road having been sealed.

The taxpayer operates a primary production business on land in Australia.

The taxpayer uses a road that runs through their property in their daily business activities. The road does not qualify as a water facility under subsection 40-520(1) of the ITAA 1997.

Rain water run-off from the road is collected via agricultural piping and directed into the main dam on the property.

The taxpayer incurs expenditure to have the road, previously gravel surfaced, sealed with asphalt.

The taxpayer states that their main reason for sealing the road is to increase the collection of rain water run-off.

The sealing of the road is an alteration to a structural improvement, being the road, and is not a structural improvement in its own right.

All references to legislation in this Interpretative Decision are to the ITAA 1997 unless otherwise stated.

Paragraph 40-515(1)(a) allows a deduction for an income year equal to the decline in value of a depreciating asset that is a water facility. The deduction for the decline in value of a water facility is worked out in equal instalments over three income years under section 40-540.

Under paragraph 40-520(1)(b) a structural improvement, or a repair of a capital nature, or an alteration, addition or extension, to a structural improvement is a water facility if it is reasonably incidental to conserving or conveying water.

The legislation does not outline the criteria to be used in deciding the degree of connection between the capital expenditure on a structural improvement, or the repair of a capital nature, or alteration, addition or extension to a structural improvement, and the purpose of conserving or conveying water.

In considering the degree of relationship between an item of expenditure and the derivation of income, the courts have held that it is the results of the expenditure, rather than the taxpayer's motive in incurring it that is the determinative factor.

In Re Magna Alloys & Research Pty Ltd v. FC of T 80 ATC 4542; (1980) 11 ATR 276, the Full Court of the Federal Court held that the taxpayer's motive in incurring the expenditure was not the critical criterion for deductibility under subsection 51(1) of the Income Tax Assessment Act 1936. At issue in that case was whether or not legal expenses incurred in defending criminal charges relating to the payment of secret commissions were incurred in the course of the taxpayer's business. The Court identified as relevant that the expenditure was apt to serve the business purposes of the taxpayer.

In that case, Brennan J. said at ATC 4551; ATR 287: Given a sufficient identification of what the expenditure is for and the character and scope of the taxpayer's income-earning undertaking or business, the question whether expenditure is incurred for the purpose of carrying on a business or for the purpose of gaining or producing assessable income does not depend upon the taxpayer's state of mind. The relationship between what the expenditure is for and the taxpayer's undertaking or business determines objectively the purpose of the expenditure.

This approach is adopted in Taxation Determination TD 94/9 which stated that, in considering whether an irrigation system installed by a fruit grower was 'primarily and principally' for conveying water, the 'primarily and principally' test requires an examination of the primary and principal function or purpose of the result produced by incurring the expenditure, rather than the purpose or motives of the taxpayer in incurring the expenditure.

The definition of 'water facility' in subsection 40-520(1) encompasses items of capital expenditure that are either 'primarily and principally for the purpose of' or 'reasonably incidental to' conserving or conveying water. It is logical to adopt the same objective test to determine whether an item of capital expenditure is 'reasonably incidental to conserving or conveying water' as to decide whether it is 'primarily and principally for the purpose of conserving or conveying water'.

Accordingly, when considering whether the fact of the road having been sealed is reasonably incidental to conserving or conveying water as required by paragraph 40-520(1)(b), the test to be applied is an examination of the objective result of the road having been sealed, rather than the taxpayer's subjective intentions, purposes or motives behind deciding to incur the expenditure to seal the road.